Tuesday, March 30, 2010

The Debts of the Spenders: Will the Private Sector Replace the Fed as a Buyer of Cheap Mortgages?

This is the thought provoking question asked in a recent Bloomberg article that posits the possibility of private investors returning to the mortgage bond market after the Federal Reserve is due to end its agency TOMO buying programing of Fannie and Freddie linked debt. The Fed's program has been instrumental in keeping long dated (10+ years) fixed rate mortgages below 5%-7% for over a year but is due to expire within a few days. It seems like such a long time ago but the Fed's intervention in the agency debt market was designed to be a temporary measure

The article's writer cites the narrowing spread as indication of just such a transition:

In December 2008, two weeks before the start of the Fed bond-buying program, the spread between the 10-year government bond yield and the average U.S. 30-year fixed mortgage rate was 3.07 percentage points, the widest since 1986, as investors demanded higher payment to compensate for risk. Last week, the difference was 1.14 percentage points, narrower than the 20-year average of 1.65 percentage points.

“Private buyers are going back into the market to pick up where the Fed is leaving off,” said David Berson, chief economist of PMI Group Inc. in Walnut Creek, California. “Credit spreads have narrowed significantly, and not just for mortgages, because investors believe the worst of the financial crisis is behind us.

Fed policy makers have made it clear in statements following the end of rate-setting meetings that they will restart the mortgage-bond buying program if needed, according to Pandl. That “backstop” has reassured investors and encouraged them to re-enter the market, he said.

Much of the demand for mortgage bonds is coming from money managers seeking to diversify their portfolios, said Berson, of PMI Group.

“Investors are full up with Treasuries,” he said. “They haven’t been able to diversify into mortgage bonds because the Fed has been buying the bulk of them. Give them an opportunity to diversify into that market, and they will.”

Source: http://www.bloomberg.com/apps/news?pid=20603037&sid=aU20MV8VOQfQ

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